When you ask a lay person what is the current state of Indian economy, we generally hear "as the market is in red (falling) for the past one week so our economy's growth is also slowing down and will be falling ", this response shows that many people view SENSEX as the indicator of Indian economy, in reality which is not the case, so this article is an attempt to unveil the reality or fact about the SENSEX and how is it calculated/computed.
The Sensex has a very important function. It is supposed to be an indicator of the stocks in the BSE (not the Indian economy) to show whether the stocks are generally going up or down. To show this accurately, the Sensex is calculated taking into consideration stock prices of 30 different BSE listed companies. It is calculated using the “free-float market capitalization” method. This is a world wide accepted method as one of the best methods for calculating a stock market index.
Please note: The method used for calculating the Sensex and the 30 companies that are taken into consideration are changed from time to time. This is done to make the Sensex an accurate index and so that it represents the BSE stocks properly.
To really understand how the Sensex is calculated, we simply need to understand what the term “free-float market capitalization” means. (As mentioned earlier, the Sensex is calculated on basis of the “free-float market capitalization” method) But, before we understand what “free-float market capitalization” means, we must understand what “market capitalization” means.
You probably think that you have never heard of the term “market capitalization” before. You have! When you are talking about “mid-cap”, “small-cap” and “large-cap” stocks, you are talking about market capitalization, Market cap or market capitalization is simply the worth of a company in terms of it’s shares. To put it in a simple way, if you were to buy all the shares of a particular company, what is the amount you would have to pay? That amount is called the “market capitalization”. To calculate the market cap of a particular company, simply multiply the “current share price” by the “number of shares issued by the company”.
Having seen what market cap is and how to find out the market cap of a particular company, let us try to understand the concept of “free-float market cap”. Many different types of investors hold the shares of a company. like the Govt. of India may hold some of the shares, some of the shares may be held by the “founders” or “directors” of the companys, some of the shares may be held by the FDI’s etc. Now, only the “open market” shares that are free for trading by anyone, are called the “free-float” shares. When we are calculating the Sensex, we are interested in these “free-float” shares.
According to the BSE, any shares that DO NOT fall under the following criteria, can be considered to be open market shares:
a) Holdings by founders/directors/ acquirers which has control element
b) Holdings by persons/ bodies with "controlling interest"
c) Government holding as promoter/acquirer
d) Holdings through the FDI Route
e) Strategic stakes by private corporate bodies/ individualsEquity held by associate/group companies (cross-holdings)
f) Equity held by employee welfare trustsLocked-in shares and shares which would not be sold in the open market in normal course.
A simple way to understand the “free-float market cap” would be the total cost of buying all the shares in the open market.
So, having understood what the “free float market cap” is, now what? How do you find out the value of the Sensex at a particular point? Well, it’s pretty simple
First: Find out the “free-float market cap” of all the 30 companies that make up the Sensex
Second: Add all the “free-float market cap’s” of all the 30 companies
Third: Make all this relative to the Sensex base. The value you get is the Sensex value.
The “third” step probably confused you. To understand it, you will need to understand “ratios and proportions” from 5th standard mathematics.
Think of it this way: Suppose, for a “free-float market cap” of Rs.100,000 Cr the Sensex value is 4000 Then, for a “free-float market cap” of Rs.150,000 Cr the Sensex value will be
(150,000 / 100,000 )* 4000 = 6000.
so the current value of Sensex is calculated based on base period of SENSEX which is 1978 - 79 and the base value is 100 index points. This is often indicated by the notation 1978 - 79 =100.
Please Note: Every time one of the 30 companies has a “stock split” or a "bonus" etc. appropriate changes are made in the “market cap” calculations.
Now, there is only one question left to be answered, which 30 companies, why those 30 companies, why no other companies?
The 30 companies that make up the Sensex are selected and reviewed from time to time by an “index committee”. This “index committee” is made up of academicians, mutual fund managers, finance journalists, independent governing board members and other participants in the financial markets.
The main criteria for selecting the 30 stocks is as follows:
1) Market capitalization: The company should have a market capitalization in the Top 100 market capitalization’s of the BSE. Also the market capitalization of each company should be more than 0.5% of the total market capitalization of the Index.
2) Trading frequency: The company to be included should have been traded on each and every trading day for the last one year. Exceptions can be made for extreme reasons like share suspension etc.
3) Number of trades: The scrip should be among the top 150 companies listed by average number of trades per day for the last one year.
4) Industry representation: The companies should be leaders in their industry group.Listed history: The companies should have a listing history of at least one year on BSE.
5) Track record: In the opinion of the index committee, the company should have an acceptable track record.
for more information on the SENSEX
http://www.bseindia.com/about/abindices/bse30.asp
Hope this article has cleared some of the doubts/myths about the SENSEX value,
follow this space for many more informational articles.
Article Contributed by
Mohit Sachdeva
MBA Core - II year
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